The origins of the Forex market go back to long periods of time and can be traced back to the Middle Ages, which witnessed the beginning of the exchange markets with the invention of the idea of exchanges by banking traders. The use of third parties allowed for more flexibility and consequently, transactions in the trading markets witnessed a tremendous growth.
The modern Forex market has seen periods of high volatility followed by other periods of relative stability. In the mid-1930s, London turned into the main center for foreign exchange trading, while the British pound played the role of the standard currency in circulation, in addition to being the first reserve currency.
After the end of World War II and the devastation in the British economy in its aftermath, the United States was the only superpower that emerged from the war without tragic effects, which opened the way for the US dollar to rob the role of the pound sterling as the reserve currency in many countries. This role was strengthened after the US dollar was pegged to gold at $ 35 an ounce, which made it the global reserve currency to this day.
The era of free currency circulation began with the end of the 1970s. Such a transformation was a milestone in the history of world markets during the twentieth century, as one of its fruits was the formation of the forex market in its contemporary concept. Since then, anyone can trade any currency, the value of which is determined by the current market demand and supply factors without the need for government intervention. The foreign exchange markets have witnessed explosive growth in trading volumes since the currencies were floated and the free exchange rate regime was implemented. Trading volumes in 1977 reached about $ 5 billion, then increased to $ 600 billion in 1987, and reached the $ 1 trillion mark in September 1992, then stabilized around $ 5 trillion in 2010.
In this article, we briefly review the main factors that led to this massive growth in currency trading volumes. The main credit is attributed to increased fluctuations in exchange rates, with the increasing mutual influence of different economies on the interest rates set by central banks, which greatly affect the value of currencies, as well as the increasing intensity of competition on commodity markets, and at the same time the emergence of multinational companies It operates in different countries, and finally the technological revolution that occurred in the field of currency trading. The final factor was the development of automated trading systems and the transition to online currency trading. In addition to trading systems, the development of matching and settlement systems has brought together millions of traders from all over the world, which has inflated the brokerage markets.
The technological revolution, the tremendous advances in computer programs and communication systems, and the accumulation of experience have greatly increased the level of professionalism of Forex traders and their ability to generate profits and manage risks significantly. These factors combined contributed to the surge in trading volumes in recent years.
You can trade currencies across multiple markets, including spot market, futures, options (vanilla), binary options, and contracts for difference (CFD). Forex options and futures are only available on regulated exchanges, while binary options are available via official exchanges as well as over-the-counter (OTC) brokers. The other two types of currency trading markets, ie the CFD and the spot market, are only available on OTC platforms. This complex structure contributes to raising a kind of suspicion among novice traders about the nature of financial instruments that they deal with, as well as the difficulty of determining whether they are part of financial derivatives or not? A derivative is a financial contract whose value changes in parallel with the change in the value of the underlying asset. Purchasing a derivative contract implies that the buyer agrees to purchase the underlying asset on a specific date and at a specified price. However, it is difficult to classify all forms of currency trading according to this definition. In the following lines, we will discuss the various aspects related to the various models of forex trading and determine the extent of each of them being classified as financial derivatives.
The settlement process varies greatly for different forms of forex trading. Let us review this process in each case to sort the contracts that are classified under financial derivatives away from those that do not fall into this category of assets. If the settlement process is based on the exchange rate of the currency in circulation in another market, then the relevant market in this case will be classified within the financial derivative markets.
The spot market
The T + 2 settlements rule applies when trading forex in the spot market. This means that all transactions (major currency exchanges) will be settled within two business days from the execution date. There are important exceptions to this rule with some currency pairs such as USD / CAD, USD / TRY, USD / TRY, USD / PHP, USD / RUB, USD / KZT, and USD / PKR, to which the T + 1 rule applies. Thus, it can be said that the short settlement period and actual delivery of the underlying assets (even though Forex brokers use the rollover mechanism to avoid handing over assets) clearly indicates that spot forex contracts are not classified as financial derivatives.